Viva Energy's float asks investors some big questions

Chanticleer
June 18, 2018
AFR 

Finally, a big float looks like making it to the ASX finish line.

As reported by The Australian Financial Review’s Street Talk column on Monday, the $4 billion-plus float of petrol refiner and retailer Viva Energy is looking more likely as the company has secured $1.3 billion from cornerstone investors. 

Viva’s prospectus is due to be lodged with the corporate regulator this week, meaning the marketing of the deal by Bank of America Merril Lynch, Deutsche Bank and UBS can accelerate.

After the last-minute termination of the Propsa float in recent weeks, and the postponement of other big floats such as Quadrant Energy and Latitude Financial, getting Viva over the line will be a shot in the arm for investment bankers.

There will be opportunities for Viva to improve the efficiency of its Geelong Refinery which could boost refinery earnings.

But the Viva float won’t just be fascinating for its impact on investment banking league tables.

Viva operates a network of more than 1200 service stations under the Shell brand. Viva’s Shell Coles Express outlets are run in conjunction with Wesfarmers’ Coles division.

Viva will provide investors with a mix of the defensive and the volatile, and also ask them to make a call on some big, long-term issues. 

The volatility that many fund mangers will focus on stems from Viva’s refinery business, which accounts for just under a quarter of underlying earnings. Naturally, the business is exposed to movements in the oil prices and currencies, which can have a big impact on profitability and valuations. UBS suggests that every $US1 change in refiner markets equates to a 10 per cent change in the group’s enterprise value. 

There will be opportunities for Viva to improve the efficiency of its Geelong Refinery (doubts about the future of which have been well and truly put to bed) which could boost refinery earnings. But investors will want to be comfortable with some exposure to a business where the whims of that cartel called OPEC have a real impact. No doubt the Viva deal team will have a weather-eye on the OPEC meeting set down for this week.

If you can live with that volatility, the defensive aspects of the business will be attractive. Fuel retailing is as close to an essential service as you can get and, on the UBS numbers, Viva was able to lift earnings at around 17 per cent a year between 2015 and 2017 thanks to increasing demand and its ability to get a bigger slice of profits under its alliance with Coles. 

In the short to medium term at least, the convenience business remains a big opportunity – albeit one that is somewhat difficult to grasp if the recent results of Coles and Caltex are anything to go by. Neither appears to be shooting the lights out, although the trends – such as more online shopping backed by more collection points and the overseas experience where fuel convenience stores are a key channel – certainly make sense. 

UBS also points to an opportunity for Viva to boost earnings if it can mirror Caltex and increase sales of premium fuel mixes, such as the new V-Power Diesel, which has just been launched. Mirroring the Caltex product sales mix results would boost retail earnings by 2 per cent per litre on the bank’s numbers.

Of course, investors may have one eye on the rise of electric vehicles, and the longer-term demand outlook for petrol. UBS has global demand peaking in 2035, which is less than 17 years away. Will a shift towards more EVs happen slowly and then accelerate, or is this threat overdone? A big picture question no doubt, but still a relevant one.

All of this will come down to price, of course.

UBS values the business at between $4.9 billion and $6.2 billion, or between 7.4 times and 9.5 times enterprise value to earnings before interest, tax, depreciation and amortisation of around $634 million in 2018-19. Caltex trades at 7.3 times, the same as the median multiple of similar integrated players around the world.

Investors will discount that pre-IPO view of the Viva valuation. The size of that discount looms as the big question.